The chancellor, George Osborne, has defended the government's economic strategy and described the threat to Britain's AAA credit rating as a reality check on the need to confront the country's debt.

Osborne backed the coalition's austerity plans after the Moody's ratings agency put the UK on "negative outlook" amid fears over weaker growth prospects and potential shocks from the eurozone crisis. The move has increased the chance of Britain being stripped of its triple-A status.

The shadow chancellor, Ed Balls, said the decision presented a significant warning to Osborne and his deficit reduction strategy. He accused the chancellor of being in denial about the need for a new approach.

But Osborne insisted the announcement underlined the fact that Britain "can't waver in dealing with our debts". He told the Today programme that failure to do so would put the country's economic reputation on the line.

"Here is yet another organisation … warning Britain that if we spend or borrow too much we are going to lose our credit rating but, more importantly, what that leads to potentially is a loss of investor confidence in our economy," he said.

"If people don't invest in our economy, you don't get growth and you don't get jobs, so I think it's just yet another reminder that Britain doesn't have some easy route out of the economic problems that have accumulated over the last decade. It's got to confront those problems head on – and that's precisely what I intend to do."

The chancellor admitted that Britain's growth prospects "have been a challenge", but warned that, without confidence in the country's ability to pay its debts, negative growth would ensue with "no prospect of recovery".

"That is precisely why I don't see this false choice between growth and dealing with your debts," he added. "If you don't deal with your debts, you won't have growth."

Also speaking on the programme, Balls said the credit agencies served as a weather vane that now showed the wind was blowing in a difficult direction because of a lack of economic growth.

He said: "A change of course is needed … It is a disaster for our country and the world to make the mistake of the 1930s. The ratings agencies are starting to get there. I'm afraid our chancellor is still in complete denial about the state of the economy and the failure of his policies. And, in the end, somebody will have to clear up George Osborne's economic mess."

He admitted that government deficits needed to be slashed, but added: "That means tough decisions – but unless you've got growth, if your plan is unbalanced, it becomes self-defeating. Today is the first evidence that even the ratings agencies are waking up to the fact George Osborne's plan is not working."

Speaking later, Osborne claimed the Moody's report showed that Labour's policies would lead to Britain suffering a credit rating downgrade.

"What Moody's is warning us today is very clear," he said. "They say Britain's rating would be downgraded if there was a reduced political commitment to dealing with our debts, if there was any extra discretionary spending or borrowing.

"Now, that is what is urged upon me by my political opponents in parliament and elsewhere. We have had the clearest possible warning that it would lead to an immediate downgrade of Britain. And why is that significant? Because it would be a symbol that investors didn't have confidence in Britain."

Danny Alexander, the Liberal Democrat chief secretary to the Treasury, said the government's plan to tackle the deficit was "the right policy" for the country.

"I do not believe that the answer to the problems is to step away from our plans and cause higher interest rates," he said. "That would be the worst thing for our economy at this difficult time."